Tag Archives: Economics

A Matter of Trust

supply_demand

I fell in love with economics, in part, because it made so much sense. Just about everything could be boiled down into a supply and demand chart that even I, with my limited artistic skills, could draw, freehand. In a free market (the basis of all things good in this world) and in our economics 101 diagrams, the goal was to get everything, neatly, to equilibrium. It was glorious! In every situation, supply and demand, in a free market, would come to a price where both parties were happy and all goods and services to be sold were bought. In equilibrium, there were no shortages, there were no overages and the price was right. For instance, say guy made Twix bars and was selling them for five cents. He would likely find that a lot of people, including those who might ordinarily prefer Snickers, would be clamoring to stock up on Twix bars. Chances are that this guy would sell out of Twix bars in no time. People seeking these cheap, and now sold out, Twix bars might start placing ads on Craigslist, perhaps even offering ten cents for a Twix bar. Others might go to the Twix maker and offer him ten cents a bar to be put on a pre-sale list. Some people might see how well the Twix bar maker is doing and decide to start making Twix bars too. In the world of the perfect graphs, this cycle would go on, with the Twix makers raising their prices a little more and making more Twix bars, in response to the great demand for the chocolate bars. However, as the price goes up and gets closer to the price of a Snickers bar, some of the people who are not so crazy about the Twix will find that the higher price is not enough of a bargain for them, so they will no longer want to buy the Twix bar at this high price. The Twix makers might get too excited about the demand for the chocolate bars and decide to raise the price to two dollars. Even though a few Twix or nothing people might be willing to sacrifice all for a Twix, most people would tell the Twix makers that they are crazy and go looking for an alternative. The Twix makers would then find that the Twix bars are going old and stale in their storage facilities and they are not selling enough chocolate to even cover their costs. To resolve this, they will lower their prices and reduce production, until they get to the point where the price is such that sellers have enough unexpired Twix bars to sell to everyone who comes in looking for them, no extras, no shortages. That, according to the graphs, is how a free market works.

When a monopoly exists, it messes with the free market. In the case of a monopoly, there are no other options and people have no choice but to buy a product or service from one source. This would like living in a place where you can only buy electricity from one provider. For most people in that society, they will be forced to pay whatever the electricity provider charges for electricity. Try as they might, they will not have an alternative to electricity in order to charge their mobile phones and laptops. Twix bars won’t cut it. What economists have found is that, left to their own devices, monopolies will charge more for their products and services than people would be willing to pay in a free market where they could choose their supplier. Monopolies have pros and cons. Some pros of monopolies are:

  • Stable Prices that come about because there is no one coming in and out of the market to create bidding wars, where suppliers fight, with prices, to get customers. With only one supplier, there tends to be just one price that tends to remain the same for a while.
  • Economies of Scale. This basically means that, because the monopolist is making all the product for the entire market, he is making a lot of product at one time. As a result, the large scale will lead to lower costs per unit. If the monopolist chooses to pass the savings on to the customer the customers will be able to get goods and services at a lower price than they might have in an open market with many supplies making goods on a smaller scale.
  • Research and Development may benefit from monopolies. Since the monopolies are making all the money in the market, from sales, they can take these larger profits and have more money to put towards innovations and improvements of their goods and services.

On the flip side, the cons of monopolies are:

  • Higher Prices may be a result of monopolies. Because people have no other options, the monopolies can get away with charging whatever they feel like charging.
  • Price Discrimination can happen with monopolies as well. Because they can charge whatever they want, they can decide to charge some people one price and others another price and, because customers have no options, they are forced to accept the price quoted to them.
  • Inferior Goods and Services are a possibility with monopolies. Monopolies may look at the market and decide to cut corners and produce inferior quality goods and services because they know that customers can’t go anywhere else.

Generally, monopolies are not considered to be in the spirit of the free market. Competition, that would correct inefficiencies and unfairness in the markets, does not exist with monopolies and so there is a risk that consumers can be taken advantage of. As a result, regulators tend to take steps to review mergers of large companies in order to reduce the risk of monopolies (or something close to a monopoly). The action by the regulators is related to their enforcement of antitrust laws.

Currently, several health insurance companies are fighting with the US Department of Justice. Humana and Aetna are seeking to merge into one company as are Athena and Cigna. Currently there are five national health insurance providers; the merger will leave us with three providers. The health insurance companies are touting the pros of monopolies, claiming that the mergers will lead to lower prices to consumers and increased research and development. The justice department, on the other hand, argues that, with fewer national insurance companies, there will be less innovation and there will be the risk that customers will be charged higher rates.

As we enter the complications of humans, trust, regulations and court battles, we can keep in mind the memory of the neat graphs of the perfect markets. It may help us better understand the news articles, full-page ads and other coverage of this and other antitrust actions related to other mergers and acquisition deals in the news. If not, we can take comfort in our still affordable Twix bars.

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